Making the case for Japan

On Monday 25 September, Prime Minister of Japan Shinzo Abe called for a snap election to take place in October, a year early. Japan’s economy continued to grow in the second quarter of 2017 with economists expecting positive figures in the coming months. Reports are of the view that Mr Abe’s economic record will be a significant pillar of his campaign, along with his response to the growing crisis over North Korea.

Investment companies investing in Japan, meanwhile, have performed strongly over the year to date (to 31 August 2017), with the Japan and Japanese Smaller Companies sectors returning 17% and 27%, respectively. Over the longer term, the Japan sector is up 141% over 10 years (to 31 August 2017), whilst the Japanese Smaller Companies sector is up 121% over the same period.

On Tuesday 26 September, the Association of Investment Companies (AIC) held a media roundtable with Praveen Kumar, manager of Baillie Gifford Shin Nippon, Andrew Rose, manager of Schroder Japan Growth Fund and Nicholas Price, manager of Fidelity Japanese Values to discuss the outlook for Japan and where they are finding opportunities, as well as the crisis over North Korea and Mr Abe’s decision to call a snap election. Their thoughts have been collated alongside those of other managers.

Snap election

Andrew Rose, manager of Schroder Japan Growth Fund said: “Heightened geopolitical tensions have contributed to a strengthening of Mr Abe’s domestic poll ratings, such that he has opted for snap election. Current indications are that he should win this handsomely, although, as we know, nothing is a given in politics.”

Richard Aston, manager of CC Japan Income & Growth Trust said: "Abe is looking to benefit from a rebound in his popularity and the disarray of the major opposition party to secure the mandate to continue pushing through the economic reform policies that have become synonymous with his leadership.

“I'm not sure anyone would want to call the outcome of elections after last year but it is widely expected that he will be given the opportunity to continue."

Nicholas Price, manager of Fidelity Japanese Values said: “Support for Prime Minister Shinzo Abe has rebounded in recent weeks as tensions with North Korea increased. The current consensus view is that Abe will win the election, but probably with a reduced majority. While investors widely expect Abe to re-appoint Haruhiko Kuroda as Bank of Japan governor in April next year, a weakened majority could impact this scenario.

“As a bottom up stock picker I prefer to look beyond near-term macro and political noise, and focus on company fundamentals. However, Abe’s pledge to increase government spending on education could throw up some interesting investment opportunities.”

North Korea

Richard Aston, manager of CC Japan Income & Growth Trust said: “Japan’s geographic proximity to North Korea makes it more than just an interested observer in the escalating tensions between the rogue Asian state and the United States. Increasingly aggressive rhetoric from both sides appears to have raised the risk of conflict and has certainly affected investment flows in the region. Japan, however, has many strained relationships throughout Asia and the current international spat is an extension of these difficulties.”

Nicholas Price, manager of Fidelity Japanese Values said: “Improvements in macro and micro level fundamentals have been eclipsed by geopolitical factors that have spurred demand for the yen and capped market upside. While political tensions with North Korea may drive sentiment in the near term, I am optimistic on the Japanese equity market from a fundamental perspective.”

Outlook for Japan

Richard Aston, manager of CC Japan Income & Growth Trust said: “As is the case in recent weeks heightened tensions have frequently had a detrimental but ultimately only a short-term impact on the equity market and with hindsight creates interesting investment opportunities.

“In this case the opportunity has arisen just as the domestic economy is recovering, company earnings are healthy and importantly shareholders are benefiting directly through ongoing improvements in corporate governance. Japan has consequently delivered the fastest growth in dividends of the major equity markets in recent years and yet with record high levels of accumulated cash on balance sheets and a high aggregate dividend cover, the potential for further improvements is significant. This shift in consensus behaviour is not to be underestimated."

Nicholas Price, manager of Fidelity Japanese Values said: “The current economic expansion is the third longest in the post-war period and with global growth running above trend, the near-term outlook for the Japanese economy remains favourable. Corporate earnings have recovered strongly from the second half of 2016 and the latest quarter produced a near 30% increase in net profits, led by the manufacturing sector. And with forward earnings multiples below 14x, valuations compare favourably with other developed markets.”

Praveen Kumar, manager of Baillie Gifford Shin Nippon said: “We remain very bullish on Japan and Japanese smaller companies in particular. The operating environment for the latter has improved considerably over the years. Both domestic and overseas end demand for these businesses continues to be strong.

“Government policy remains geared towards industry deregulation, with a number of progressive policies already implemented in this regard.

“A combination of a favourable operating environment and low valuations relative to developed market peers means that Japanese smaller companies represent a very compelling proposition for long-term investors.”

Andrew Rose, manager of Schroder Japan Growth Fund said: “The Japanese stock market has lagged most other markets in 2017 in spite of robust economic and corporate fundamentals. The economy has grown for 6 consecutive quarters, which has not happened for 12 years and corporate profits have entered a positive phase of the revision cycle. Valuations are relatively attractive and investors should continue to benefit from improving corporate governance, one of the main successes of Abenomics.”

Nicholas Weindling, manager of JPMorgan Japanese Investment Trust said: “Japan’s overall outlook is looking pretty healthy at the moment with several factors at play which are starting to meld together. Broadly speaking the Japanese economy is getting better, as is the global economy. Japan will stand to benefit as this continues to happen. Japan also offers investors low valuations, with price/earnings, price/book and dividend yield all looking good compared to other developed markets.”

Finding opportunities

Praveen Kumar, manager of Baillie Gifford Shin Nippon said: “Our favourite hunting ground for stock ideas is within what we classify as ‘online disruptors’. These are disruptive, innovative and rapid growth businesses usually run by young and ambitious entrepreneurs. We are continuing to find these types of companies across a number of sectors in Japan. Additionally, we are seeing a number of investment opportunities emerge due to the ongoing labour shortage situation in Japan as well as within biotech where a number of companies are developing exciting and potentially world leading therapies and drug discovery platforms.”

Nicholas Price, manager of Fidelity Japanese Values said: “In Japan, the mid-to-small cap equity space is a fertile hunting ground that offers a wealth of under-covered and under-researched names. For example, there are almost 2,000 Japanese companies covered by less than five sell-side analysts compared with around 400 in the UK. With comparatively few analysts undertaking this level of research, the alpha generating potential of smaller companies can be much more significant than for large caps given the greater market inefficiencies. And being on the ground in Japan means that we are well placed to find under-researched companies in the early stages of their development and capture the significant expansion in multiples that can occur as the story becomes more widely recognised by the market.”

Nicholas Weindling, manager of JPMorgan Japanese Investment Trust said: “We find compelling investment opportunities in structural growth areas such as the growth in the penetration of e-commerce, automation, Japan’s aging population and companies prioritising improving shareholder returns. One of the key reasons we focus on long term structural growth names is that they tend to be less sensitive to the Yen/Dollar exchange rate. We also find strong investment opportunities in new Japan brands that are growing globally, whose products stand for reliability, quality and safety.”

Andrew Rose, manager of Schroder Japan Growth Fund said: “Some of the more attractive opportunities are in cyclical parts of the market such as machinery, auto related companies and electronic component manufacturers. Amongst domestic sectors financials look undervalued and, selectively, we are also seeing opportunities in the retail sector.”

Performance data is % share price total return based on the last official close price at the month end, on a total return basis. No expenses taken into account. Source: Morningstar.

The Association of Investment Companies (AIC) was founded in 1932 to represent the interests of the investment trust industry – the oldest form of collective investment. Today, the AIC represents a broad range of closed-ended investment companies, incorporating investment trusts and other closed-ended investment companies and VCTs. The AIC’s members believe that the industry is best served if it is united and speaks with one voice. The AIC’s mission statement is to help members add value for shareholders over the longer term. The AIC has 352 members and the industry has total assets of approximately £174 billion.

Disclaimer: The information contained in this press release does not constitute investment advice or personal recommendation and it is not an invitation or inducement to engage in investment activity. You should seek independent financial and, if appropriate, legal advice as to the suitability of any investment decision. Past performance is not a guide to future performance. The value of investment company shares, and the income from them, can fall as well as rise. You may not get back the full amount invested and, in some cases, nothing at all.